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No Man Is An Island

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  • 1. Reinventing the Bazaar No Man Is An Island CHAPTER TEN presence, the extra commuting time I cause may well exceed any inconvenience I would have suffered had I not driven. My decision No Man Is an Island to drive does not take into account the full social costs of my actions. I harm others merely by driving my car. The U.S. Federal Highway Administration estimated that in 2000 Contributing to traffic congestion, I add a little to the other drivers’ the negative spillovers from driving—the costs of congestion, lateness, not to speak of their blood pressure. My car’s presence on pollution, and accidents—totaled $6 billion. Some of these social the road, even if I drive carefully, slightly increases others’ chances costs were covered by drivers: fuel and vehicle taxes and insurance of being in an accident. My car’s exhaust fumes pollute the air premiums came to $108 billion.’ The remainder is the externality others breathe. from driving. It averages about ten cents per mile driven. Economists call such unintended side effects “externalities,” **** meaning any costs (or benefits) external to a transaction or activity. An action brings an externality if it affects, without compensation, While self-directed decision-making is what powers markets, it can others than the decision- maker. Externalities can arise in any also be counterproductive. “No man is an island, entire of itself” market. Since they cause the market to underperform if they are left said John Donne in 1624, anticipating the concept of externality. An uncorrected, they may need to be addressed in the market design. externality can cause a market to malfunction. With a negative externality like pollution, the decision-maker is not accountable for The various externalities from driving are limited by mechanisms the full costs of the activity, since others bear some of the costs. Too that induce drivers to take account of their effects on others: the much of the polluting activity therefore takes place. Externalities are rules of the road help rein in careless drivers, as does the ability to not only negative; they also can be positive, as when one firm’s sue them; regulations on engine emissions put a cap on pollution; research and development spills over and benefits other firms. With and gasoline taxes raise the cost of driving. a positive externality, there is too little of the activity, since some who benefit do not pay their share. For the market to reach its full One major externality, though, mostly goes uncorrected: congestion. potential, its rules must encompass the externality by somehow Americans lost an estimated 4.5 million hours while stuck in traffic inducing decision-makers to take account of their effects on others. in 1999. In Los Angeles, Atlanta, and Seattle, the average driver spent more than an hour per week in traffic jams. By driving on a Communities sometimes solve externality problems for themselves. crowded freeway, instead of car-pooling or postponing my trip, I If few enough people are affected, they can arrange an amicable add a little time to everyone else’s journey. The delay I cause any solution. In a small country town, off the beaten track, locals drive one driver is small, but summed over all the drivers affected by my considerately out of neighborliness. The self-help solution works in
  • 2. Reinventing the Bazaar No Man Is An Island some circumstances but not others. For many externalities a bottom- Vickrey, who later won the Nobel Prize in economics for his work up solution falls short. Urban road congestion is unlikely to be on auctions, proposed a plan for pricing urban car travel in solved by everyone voluntarily driving less. Solving it requires some Washington, D.C. Roadside receptors would scan each car that broad-based decision-making. Sometimes the only workable passed, sending the data to a central computer, which would solutions are top-down ones. calculate the congestion charge and bill the driver. The fee would be larger when the congestion was greater, and zero when there was Externalities can be addressed by government-set rules that require none. people to behave in ways that mitigate their effects on others. Speed limits and other safety-based rules of the road curb driving Futuristic as the proposal seemed at the time, technology has caught externalities, as does the law against driving while drunk. The up with Vickrey’s imagination. Singapore has put Vickrey’s idea pollution consequences of driving, similarly, are addressed by into practice, charging drivers for the use of certain roads at peak controls. In Los Angeles, the freeway metropolis, vehicle exhaust times. Every car contains a dashboard unit into which the driver fumes used to be a major source of the city’s suffocating air inserts a prepaid card. Whenever the car passes a toll station pollution. Laws prohibiting leaded gasoline and limiting cars’ (mounted on an archway above the road) a fee is electronically emissions addressed the problem. extracted from the card. The fee varies with the type of vehicle and the time of day. If a car has no card, an infrared photograph is taken For large and very damaging externalities (the Los Angeles smog of the license plate and the driver is automatically fined. The caused health problems), outlawing the activity may be the only intention was “to get people to plan their trips better,” said transport- solution. It is a blunt approach, though, and the cure may be worse authority official Zainal Abidan. “If they don’t really need to use than the problem. A more finely tuned remedy is a tax. Pulling a these roads, they won’t. Traffic in the central business district during price on the externality, a tax induces the decision-makers to take it peak times fell 13 percent. into account. Once it is properly priced, the externality from congestion A tax on gasoline, by raising the price of driving, helps contain disappears. But this requires more than just the metering technology. pollution and congestion (although the externalities driving is It also requires setting the fees correctly. The point is not to raise estimated to cause are larger by far than the U.S. gasoline tax). A tax revenue for the government; it is to make people pay the true cost of on alcohol helps contain the externalities from drunk driving. their driving. The fee should be just enough to deter those who Increasing the alcohol tax, the data show, significantly reduces would value the rush-hour trip less than the congestion costs they highway fatalities. would cause others. It is hard to set the fee at just the right level, for this entails estimating the other drivers’ losses from the congestion. “If you drive a car I’ll tax the street,” goes a line in the Beatles song This difficulty arises with any externality-correcting tax, as the first “Taxman.” Even congestion can be taxed. In 1963, William proponent of such taxes, A. C. Pigou, recognized: the practical
  • 3. Reinventing the Bazaar No Man Is An Island difficulty of determining the right taxes is “extraordinarily great. corn grower would pay for the fence to be fixed. Either way, an The data necessary for scientific decision are almost wholly outcome that is better for both would be reached. Since correcting an lacking.” Taxes will not resolve an externality if they are set at the externality results in extra value being created, the market wrong level, and they may even make matters worse. participants themselves have an incentive to address it, and sometimes, given well- defined property rights, they can. Given that the price is set right, taxing the externality can make almost everyone better off. You pay a congestion tax one way or the Similarly, the threat of being sued turns the cost of careless driving other: if not in cash, it is in the time wasted and the frustration of back on you. If you cause an accident through your own sitting in traffic jams. Taxing road use would reduce congestion. For recklessness, ‘those you harm can demand compensation, and those who continue to drive at rush hour, the speedier trip is worth chances are the courts will require you to pay it. Civil law creates an the fee. incentive for safe driving. Taxation and regulation are top-down externality solutions. Another Free decision-making in the shadow of the law will not solve all solution is partly bottom-up, partly top-down. This is to define externalities: air pollution is one example. Many drivers contribute property rights (top-down) and then let people resolve their to the pollution, so those harmed by it cannot identify who to sue. externalities by bargaining within a framework defined by the law Since I cannot be sued, the courts provide me with no incentive to (bottom-up). Any externality can be viewed as resulting from the limit the harm I do. Taxes or regulation are the only workable incompleteness of property rights. If the air were private property, solutions when the source of the damage cannot be pinned down. the owner could charge polluters for the “use” of it, and then there would be no externality. No one can own the air, of course, but in Externalities are ubiquitous, so every one of them cannot and should some other cases broadening property rights can be an effective not be taken into account, but where they are sizeable, they must be solution. addressed if the market is to work as it should. Which externality solution is the best varies with the circumstances. The checkered Given clearly defined property rights, individuals may negotiate a history of ocean fishing, which I will turn to next, is a case study in mutually beneficial solution to an externality, as Nobel laureate externalities. Just about every possible solution has been tried— Ronald Coase pointed out. Imagine a cattle rancher who harms his usually with a notable lack of success. neighbor, a corn grower, by not maintaining the fence, so the cattle wander into the cornfield and damage the crop. Suppose that fixing **** the fence would create value (since the repair cost is smaller than the cattle’s damage). If the corn grower has recourse to the courts, then In Cannery Row John Steinbeck portrayed the lives of workers in the cattle rancher would fix the fence under the threat of being sued. the pilchard canneries of Monterey, California, in the 1930s and Alternatively, depending on how the law assigns responsibility, the 1940s. In the less well-known Sweet Thursday he returned to the
  • 4. Reinventing the Bazaar No Man Is An Island Monterey of the early 1950s. By then the canneries had closed. The subsidizing ever-larger boats, the Georges Bank fishery off New industry had collapsed, following the disappearance of the fish. England, once highly productive, was fished out. Doling out There had been a natural decline in the fish population resulting subsidies is a way to avoid inducing the industry to adjust to new from a drop in ocean temperatures. But in part the demise of the realities. It hastens the depletion of fish stocks: United Nations Food fishery, to Steinbeck’s dismay, was man-made. “The canneries and Agriculture Organization (FAQ) statistician Christopher themselves fought the war by getting the limit taken off fish and Newton said, “The history of fishing is to postpone problems until catching them all. It was done for patriotic reasons, but that didn’t you run out of fish.” So heavy is the subsidization that, according to bring the fish back. As with the oysters in Alice, ‘They’d eaten every the FAO, $90 billion is spent each year around the world to catch one.’ . . . Cannery Row was sad when all the pilchards were caught $70 billion worth of fish. and canned and eaten.” The main reason for overfishing is not the subsidies, however, but Fisheries today are in a state of crisis. The management of marine an externality. Overfishing occurs primarily because the fishers ecosystems “has failed to achieve a principal goal, sustainability,” respond to the incentives they face. according to marine biologists Louis W. Botsford, Juan Carlos Castilla, and Charles H. Peterson, writing in the journal Science. Fish swim freely, so fishing is different from farming. The open “Almost a half of the individual fish stocks are fully exploited and ocean and its contents cannot be parceled out as land is. Property another 22 percent are overexploited.” As a result, “the global rights are hard to monitor and enforce. No one owns the fish before marine fish catch is approaching its upper limit.” A subsequent they are caught. With ill- specified property rights, the market works study in Science by nineteen of the world’s leading marine badly. Biology sets a maximum extraction rate. If too many fish are biologists concluded that the overfishing had been going on for caught, too few are left in the ocean to reproduce at a rate that many centuries, leaving many fish populations disastrously maintains their population at a sustainable level. Free-market vulnerable, and concluded, “Even seemingly gloomy estimates of incentives, however, lead to overfishing. the global percentage of fish stocks that are overfished are almost certainly far too low.” In the United States alone, species such as red “Right now, my only incentive is to go out and kill as many fish as I snapper, New England cod, Chesapeake Bay blue crab, swordfish, can,” said John Sorlien, a Rhode Island lobsterman. “I have no Atlantic billfish, winter flounder, shrimp, tuna, and shark suffer incentive to conserve the fishery, because any fish I leave is just from overfishing. What causes the chronic overfishing? going to be picked by the next guy.” His logic is watertight. The fish will be caught and will not reproduce, even if he behaves Governments are part of the problem. Countries such as Spain and responsibly and refrains from catching them. He cannot by himself Taiwan subsidize their fishing fleets, in the name of preserving ensure the fish stocks are maintained. His choice is to catch either a employment, resulting in an overcapacity that creates pressures to large number today and few tomorrow, or a smaller number today overfish. As a result of the U.S. and Canadian governments’ but no extra tomorrow. Responsible behavior goes punished. There
  • 5. Reinventing the Bazaar No Man Is An Island is a race to fish. The logic of the situation traps each fisher into of ocean. In exchange, Ocean Farming pays the government a taking as many fish as he can. There is an externality, in that others royalty of 7 percent of the value of the fish it harvests.’ bear the costs of one’s own overfishing, Ceding control of the oceans to a single fishing company, however, The fishing industry takes 8o to 84 million tons of fish each year is not usually practical or politically desirable. The Marshall Islands from the world’s oceans. According to the World Wildlife Fund, had no domestic commercial fishing industry, so there was little fishing at a rate that would allow the fish to regenerate would mean opposition to contracting out the entire ocean. (Local island fishers catching just 6o million tons per year. Jim Leape of the wildlife fund are permitted under the contract to continue small-scale fishing for said, “The oceans can no longer absorb the abuses we have piled on their own needs.) Most fisheries around the world support many them.” How can overfishing be prevented? The various solutions independent fishing boats, whose owners and crews would mobilize that have been tried cover the full range of externality remedies. political opposition against a monopolization of the fishery. For this and other reasons, single-owner solution is usually not an option. A If the ocean were controlled by a single owner who expected to variety of other solutions to the problem of overfishing have been continue to own it in the future, the problem would be solved. The tried, both formal and informal, with varying degrees of success. single owner would recognize that his self-interest lay in conservation. A single-owner fisher benefits tomorrow from leaving Communities of fishers sometimes devise informal solutions: fish in the ocean today. collective mechanisms to counter overfishing. In the Bahia region of northern Brazil, fishers work within an intricate code of conduct The idyllic palm-fringed coral atolls of the Marshall Islands dot the governing both the total amount of fish that can be taken and how Pacific Ocean five hours’ flight west of Hawaii. Their population much each of them may take. The members of the community and landmass are tiny: sixty thousand people live on a total area of sanction those who violate the code, refusing to speak with them in seventy square miles. But because there are more than twelve social situations or sabotaging their boats and nets. In Tonga, fishers hundred widely scattered islands and because all the ocean within obey social norms requiring them to share their fish. Anyone who two hundred miles of land is in their territorial zone, the Marshall catches more than his family can eat must give it away according to Islands government controls a vast swathe of open ocean. The ocean rules that favor the needy and the elderly. The local fishing is their main resource. Remote and unassuming as they are, the communities of Japan also manage their resources in a sustainable Marshall Islands are perhaps unique in the world in their fishery way. Because they have specific geographic boundaries and the management. The government has implemented the single-owner same families engage in fishing from generation to generation, all solution to the overfishing problem. It made an exclusive agreement understand the code of conduct and social sanctions effectively with a U.S. private company, Ocean Farming Inc., under which it support it. In the U.S. state of Maine, some communities regulate alone may fish the Marshalls’ eight hundred thousand square miles lobster fishing in local waters, determining who may fish when and where. They back their conservation measures with force. Anyone
  • 6. Reinventing the Bazaar No Man Is An Island who flouts the community’s rules risks having his traps cut free or of the fact that no one owns the fish—by establishing property even having his boat sunk.” rights. By eliminating the externality each fisher’s decision imposes on the others, quotas eliminate the race to fish. Informal solutions work only within tight-knit fishing communities. With large, anonymous groups of fishers that outsiders can enter, Quotas mean the fish are able to reproduce, making future fishing social sanctions hold little sway and so government intervention is easier. Rick Garvey, a biologist who monitors quota compliance for usually needed to prevent overfishing. the Australian government, said, ‘Fishing may be the only economic activity in which you can make more money by doing less work.” Regulating fisheries, governments have imposed controls on the number or size of boats. They have specified that fishing can take The countries that have gone furthest in establishing fishery property place only within a certain season. Each of these is a blunt form of rights—including New Zealand, Canada, and Iceland—allow quotas control, and each leads to predictable distortions. Regulatory to be bought and sold like any private property. A new entrant or an controls on inputs induce the fishers to compensate by overusing incumbent wanting to expand needs to buy quotas. This means the whatever inputs are unregulated. Restrictions on the number of quotas end up with the most efficient producers. Unlike under boats have brought bigger boats with extra equipment and crew. regulation, the fishers have reason to invest in productivity- Restrictions on the length of the vessels have induced companies to improving skills and equipment. build wider, heavier boats. Restrictions on the number of crew have resulted in investment in high-tech fishing gear; adding electronic Quota holders have a large stake in preserving the fishery in order to devices for locating fish increases a vessel’s catch dramatically. maintain the value of their quotas. In New Zealand, the fishers have Restrictions on equipment, on the other hand, have meant extra crew formed associations to fund research aimed at conserving the stocks being hired. A short fishing season induces firms to invest in high- of scallops, snapper, and orange roughy. capacity boats so they can catch as much as possible in the time allowed; the investments sit idle for the rest of the year. A short Halibut fishing off British Columbia, Canada, was in a state of crisis season also means that for much of the year the fish must be in the 1980s. Catches had plummeted. The regulators successively delivered frozen to the customer, providing less value than if it were reduced the length of the fishing season in a vain attempt to prevent fresh. overfishing, to such an extent that by 1990 fishing was allowed for just six days of the year. The exceedingly short season meant that Recognizing these distortions from regulation, some governments fishing was intense. Fights would break out among the fishers for have switched to a new, more market-based method of conservation. the best areas. Safety was compromised as boats stayed out even in Rather than controlling inputs, the regulators assign to each fishing dangerous weather. After the regulators introduced individual quotas vessel a quota, defining how much it is allowed to catch. Quotas in 1991, the economic efficiency of the halibut industry improved directly address the basic issue— that overfishing is a consequence significantly. The need for the short season disappeared, so fish were
  • 7. Reinventing the Bazaar No Man Is An Island caught when needed and marketed fresh. The number of active boats ocean fishing come only if the government expends sizeable fell. Fishing became a more profitable and less acrimonious activity. bureaucratic, investigative, and enforcement resources. Conservation was achieved. No system of monitoring, moreover, is infallible. New Zealand goes **** to greater lengths than most countries to prevent out-of-quota fishing. It insists on full documentation, with paperwork recording The fishery illustrates the force of property rights. Overfishing each step of the fishes’ journey from point of landing to final occurs because no one owns the fish before they are caught. consumption or export. Fishers may not sell fish to anyone other Creating property rights, by means of quotas, removes the incentive than a licensed fish receiver. Catch reports, licensed-fish-receiver to overfish. But it is an imperfect solution, for the monitoring of the receipts, cold-storage records, and export invoices are all collated property rights is expensive and leaky. and checked for discrepancies. Overfishing and misreporting are criminal offenses. Fishery officers police the illicit trade in fish with Workable property rights in fish are not created by the stroke of a a Zeal that recalls Elliott Ness’s crusade against alcohol sales in the pen. Quotas do not eliminate the need for regulatory supervision. prohibition-era United States. In a typical incident, a man was The regulator must devise rules on who initially receives the quotas. arrested for selling a sackful of unauthorized crayfish (or rock Dividing up the rights to the catch is inevitably a source of lobster) at a pub. Even so, the poaching persists. An estimated 450 contention among the fishers. Ongoing and extensive government tons of crayfish are sold on the black market each year. This is one- monitoring is needed to check that the catches do not exceed the seventh the size of the legal catch. It is almost impossible to quotas. This is intrusive and costly, for activities at sea are harder to perfectly enforce property rights in fish. monitor than most land-based activities. Official inspectors check catches upon landing, and there are stiff fines for exceeding quotas. Quotas are still harder to implement if more than one country is In the British Columbia halibut fishery, every single fish is tagged involved. Many fish swim between jurisdictions. Swordfish, for with the vessel’s code as it is landed on the dock so it can be traced example, migrate widely, back and forth between equatorial areas to through to final use. Some regulators require vessels to carry on- cooler waters, so conserving their stocks requires international board observers or video cameras. Some countries, such as cooperation. More than thirty countries harvest swordfish, and Australia, use military aircraft to patrol their waters, checking for genuine conservation requires that they all agree on the limits and on boats that should not be there. Even the most sweeping solution to how cutbacks are to be shared. Where large sums of money are the problem of overfishing, granting monopoly rights as in the involved, international agreements are hard to come by, and Marshall Islands, does not eliminate the need for oversight from the negotiations often fail. government, for it must be able to monitor the fishing company’s catches to be sure it is receiving its due royalties. Property rights in International confrontations over fishing periodically hit the headlines. A Russian gunboat once rammed a Japanese fishing boat
  • 8. Reinventing the Bazaar No Man Is An Island in the Bering Sea. South African officials once detained a Spanish regrettable that Japan’s views were not fully understood,” said trawler for using illegal twenty-kilometer-long nets. Icelandic and Foreign Minister Masahiko Komura after the ruling. The Norwegian fishing boats have exchanged gunfire in the North Sea. “experimental” fishing beyond quota continued. Factory fishing in the South Pacific by Japanese and Taiwanese boats has led to regular disputes with various island states, The fishery, in summary, is impervious to perfect management. In a sometimes with boats being seized. Declining fish stocks sparked a fixed and stable community of fishers, codes of behavior backed by tuna war in the Bay of Biscay between Spain and the United social sanctions can confine fishing to a sustainable rate. But in most Kingdom, a turbot war in the North Atlantic between Canada and fisheries new fishers can enter, so there is no such stable Spain, and a cod war in the North Sea between the United Kingdom community, and an absence of government oversight brings and Iceland. disastrous overfishing. Government regulation of fishing, on the other hand, causes distortions and in any ease usually fails to avert Some international accords have been negotiated. The United States the overfishing. The best feasible solution is catch quotas. By and Canada operate an agreement on sharing Pacific salmon. Japan, creating property rights, quotas directly tackle the externality of the Australia, and New Zealand have an agreement that defines country- fishers’ decisions on how many fish to take. While this is the most level quotas on the southern bluefin tuna. In both cases the market-oriented of the solutions, it can be implemented only with negotiations were concluded only after animosity had undermined extensive government monitoring. relationships between the contending countries. Let us turn to another market encumbered by an externality that is Compliance with international quotas is still more uncertain than resistant to solution: the labor market for sports stars. with domestic quotas, because enforcement is more problematic. In 1999, five years after the bluefin tuna agreement was signed, **** Australia and New Zealand complained to an international maritime tribunal that Japan had overfished in violation of the agreement. A noisy demonstration took place in Kansas City in May 1999 over “Japan is putting in jeopardy a very important, highly migratory a curious kind of injustice. “Share the wealth,” the protesters’ stock that is already in a seriously depleted state,” said Tim placards demanded. What had aroused their anger was not world Caughley, a New Zealand government lawyer. Japan’s officials hunger or globalization or the environment or civil rights—it was a defended its fishing as “experimental.” The sixteen hundred tons of perceived inequity in baseball. The demonstration took place at a above- quota tuna that Japanese boats had caught in one year were game between the Kansas City Royals and the New York Yankees, “essential” to its research efforts to assess the bluefin tuna as some five thousand fans stormed out of the stadium. Some of population. (The “experimentally” caught tuna ended up being them wore Yankees caps with dollar bills stuck to them, to auctioned in Japan’s fish markets for use as sashimi, fetching up to symbolize that money rules baseball. $100 per kilogram.) The tribunal ruled against Japan. “It is
  • 9. Reinventing the Bazaar No Man Is An Island Odd as the incident was, the protesters had a point. The baseball significantly affect attendance. But if the quality of each separate players’ labor market is skewed. The Yankees splurge on players. team is held constant, attendance is higher when a close contest is Lavish spending translates into on-field success. That success can be expected (as measured either by the betting odds or the difference bought is illustrated by the Florida Marlins. Spending freely, the between the two teams’ recent win percentages). Statistical studies newly founded club won the 1997 World Series. The next year it cut of other sports, like American football, Australian-rules football, its payro1l to less than one-fifth of what it had been by trading away international cricket, and English soccer, also conclude that more its best players, becoming the worst team of the year. Between 1996 fans show up at games that are expected to be close.’ and 2000, the only other club to win the World Series was the Yankees, the club with the league’s largest salary bill. Of the 189 The history of professional sports in the United States shows the postseason games played from 1995 and 2000, just three were won value of an even competition. The league structure evolved slowly. by teams in the bottom half of the salary distribution. The gap The first professional teams in baseball and basketball were between the payroll for the lowest team and that for the highest in “barnstormers,” like basketball’s Harlem Globetrotters: they played 1989 was $30 million; by 1999 it had grown to $160 million. The exhibition games intermittently against each other and against sportscaster Bob Costas said pay disparities are the root of amateur teams. Initially, therefore, the teams were autonomous. baseball’s ills, threatening to create a “monopoly on sustained After about twenty years, however, they relinquished their success.” independence and formed themselves into leagues (baseball in 1871, basketball in 1937) The formation of the leagues was a response to “There is no way we can be competitive,” complained one of the consumer demands. The barnstormers, winning easily against much Kansas City protesters, a Royals fan. “They are more of a circus act weaker opponents, offered a spectacular exhibition of their players’ than a baseball team. You go out there for the carnival atmosphere. skills. But it soon became clear that fans preferred, and were more You don’t go there to watch a competitive game.” Or you don’t go likely to attend, organized championships. Exhibitions of skill were at all. The lack of competitive balance in the league harms all the not enough: fans wanted intense play and the tension of winning and teams, not just the poorer ones, as some fans will not pay to watch losing serious games. Professional sports attracted large numbers of predictably one-sided games, and television ratings will fall. Fans paying spectators only after the leagues were formed and rules were like their own team to be somewhat better than the opposition, but put in place to provide reasonably balanced competition.’ not too much better. A team that wins with absolute inevitability is almost as boring as one that perpetually loses. Healthy sporting competition requires a reasonably even distribution of player talent, then, so that there is a competitive balance among The data on attendance at baseball games confirm that competitive the teams. Every team in the league has a stake in keeping the balance matters. A close competition is not the only thing. Fans like competition somewhat even. Nevertheless, the teams in large- to watch the skills of outstanding players like Derek Jeter: the data population regions tend to bid away the best players. show that the quality of both the home team and the visiting team
  • 10. Reinventing the Bazaar No Man Is An Island An externality generates the imbalances in baseball. A strong team externality, a degree of coordination is needed—some rules to acquiring extra stars increases its share of the pie by raising its govern the players’ labor market. chances of winning, but it shrinks the total size of the pie by unbalancing the on-field competition. A lopsided player trade affects **** not just the two teams directly involved, but also, via its effects on competitive balance, the entire league. But since each team bears Here is the catch. It is the league that sets the rules on the movement only a fraction of the harm its trading causes the league, individual of players among teams, and the league’s motives are mixed. teams have inadequate incentives to promote competitive balance. Achieving competitive balance is one of its goals, but not the only When the New York Yankees acquired the slugger Jose Canseco in one. The league consists of the teams’ owners, who have a stake in 2000 on a salary of $3 million a year plus bonuses, for example, the holding down the players’ salaries. Anything that restricts New York Times commented, “they don’t really want him or need competition among the clubs for players is in the club owners’ him; they just wanted to make sure he wasn’t going to play mutual interest. “In no other labor markets;’ noted economists anywhere else.”20 Because the benefits of an even sporting Sherwin Rosen and Mien Sanderson, “are employers collectively competition are shared by all the teams, a team might bid for a star allowed to impose restrictions on payments to workers.” regardless of the effects on the league. Over the years, sports leagues have introduced numerous policies in Now imagine a weak team that lacks the player talent to reach the the name of competitive balance. In many of these instances playoffs, and is unlikely in the foreseeable future to acquire competitive balance has merely been a subterfuge for holding down significantly better players. The club may be tempted to profit by the players’ pay. The policies adopted by the major U.S. trading away any star players it has, for its hard-core fans would professional sports leagues—the reserve clause, the rookie draft, continue to pay to attend games even if it dropped from, say, twelfth salary caps, and revenue sharing—have often failed to achieve in the league to eighteenth. Profitable as this is for the individual competitive balance. But they have succeeded in keeping the team, it harms the collective interest of all of the teams by making players’ incomes down. the competition still more uneven. A form of involuntary servitude called the reserve clause, introduced Spectators and teams value an overall sporting competitive balance. by baseball in 1880, bound the player to a club for his entire playing But rich teams are tempted to bid for all the best players and weak career. The club could sell the player to another club, which then teams are tempted to sell off their best players. Competitive balance received the remaining career-long rights to him. The reserve clause is unlikely to be achieved, therefore, without some limits on player did not induce balanced competition, because rich teams still bought movements. A completely free market for players’ services would any players they wanted (the data show no increase in the not work well. To take account of the competitive-balance unevenness of baseball teams after it was abolished). Its only effect
  • 11. Reinventing the Bazaar No Man Is An Island was to limit the players’ salaries, which eventually led, in 1976, to players to the owners. Capping the players’ salaries is a blunt the courts ruling it illegal. instrument for competitive balance. The rookie draft in American football operates by reverse order of Revenue sharing among teams is one of the more effective finish: the team doing worst in the competition gets the first choice competitive balance policies. Redistribution occurs via ticket and of rookies. By restricting the market for rookies, this limits rookies’ television revenues. National television revenues are shared equally salaries. Like the reserve clause, it seems to have had little effect on among the teams in the major U.S. sports, but local television competitive balance. Rich clubs buy the best players, regardless of revenues are not shared. In basketball and ice hockey, gate revenues where they are drafted initially. are not shared with the visiting team, though as noted, basketball has league-wide sharing of revenues with players. In the American A salary cap—a specified limit on team spending on salaries—is League of baseball, the visiting team gets 20 percent of gate another policy intended to achieve balanced competition. This is revenues and the home team 8o percent; in the National League, the used by the National Basketball Association and the National corresponding numbers are and 95 percent. In baseball, the richer Football League. A share of gross league revenues is designated to teams pay a tax (which went as high as $17 million per team in go to the players (48 percent in basketball and 63 percent in 2000), while the poorer teams receive payments (of up to $23 football). That sum is then divided by the number of teams in the million per team in 2000). Football does the most revenue sharing of league, to give the maximum payroll per team. Though the salary the major U.S. sports. The ticket receipts are divided 60/40 between cap is generally viewed as having had some success, it is not hard to home team and visitor. There is no local televising of games, and evade, and it has not equalized spending on salaries in basketball. In national broadcast revenues are shared equally among the teams. 1997—1998, the Chicago Bulls and the New York Knicks had Together with salary caps, revenue sharing has allowed the Green payrolls 2.5 times larger than those of the Los Angeles Clippers and Bay Packers, for example, who play in the smallest city of all the Milwaukee Bucks? This variation occurred because of football teams, to be competitive; revenue sharing accounts for exemptions: for example, a team may match outside offers made to nearly two-thirds of Green Bay’s receipts. The downside is that the its players. The true gap, however, is probably much larger than teams that draw in large numbers of spectators by playing published salaries indicate, because of creative accounting, deferred attractively are called upon to subsidize the teams no one wants to payments, and unreported payments. “We have spent substantial watch. hundreds of thousands of dollars of the owners’ money;’ said NBA commissioner David Stern, “to make sure that the agreement is lived In U.S. sports, then, the reserve clause and the rookie draft have up to by the owners themselves.” redistributed money between players and clubs but have done little to balance the competition. Salary caps are often evaded, and only The salary cap means that small-market teams can, and do, win the limited revenue redistribution has been achieved. While these basketball championship. But it also transfers earnings from the methods are potentially effective, neither fully addresses the
  • 12. Reinventing the Bazaar No Man Is An Island problem of competitive balance. Salary caps put the burden on the players into the league’s rule-setting process, though this is unlikely players rather than the clubs, and revenue sharing penalizes success. to occur unless the players’ union is powerful. A good design for a The problem of competitive balance has been solved, at best, sports labor market is yet to be implemented. In market design, it partially. matters what the interests of the designer are. Outside the United States, two further policies toward even **** competition are used. One is to split the teams into higher and lower divisions, each with its own separate competition. The competition Sometimes a market spontaneously arises to take care of an within each division is more even than it would be if all teams externality. Beekeepers provide a benefit to fruit growers, as the competed with each other. At the end of each season, the worst bees pollinate the fruit trees. If this were not rewarded, too few bees teams are relegated to a lower division, and the best teams in the would be housed near the orchards. In the state of Washington, lower divisions are promoted, thus providing additional incentives to growers pay beekeepers to place hives among their trees. The perform. The divisional structure has the advantage of punishing beekeepers move with the seasons: in the early spring they put their failure, not success. hives in the cherry orchards in the south of the state, then in the late spring they truck them northward to the apple orchards. The fruit The other policy is transfer fees. The club acquiring a player pays a growers pay the beekeepers pollination fees. The would-be fee to his current club. The fee is negotiated, and if the offered fee is externality is addressed by contract. too low, the current club can block the trade. Transfer fees can mount up: in European soccer in the late 1990s, fees of $20 million Some externalities are not resolved as easily as that though, or more were not uncommon. To acquire the player Luis Figo in pollution being one example. An infamous case occurred in 2000, Real Madrid paid Barcelona a transfer fee of $56 million. Minamata Bay, Japan. The Chisso Corporation, a chemical Transfer fees seem to have been no more successful than the other producer, dumped tons of industrial waste containing mercury into policies in generating competitive balance. In English soccer, for the bay between 1932 and 1968. The local people contacted mercury example, the same handful of clubs dominate its Premier League poisoning from eating seafood. Brain damage and paralysis year in and year out, According to Viviane Reding, a European followed. “I saw patients screaming and scratching the walls in Union commissioner, transfer fees had failed to prevent “the agony,” said Eiko Sugimoto, a survivor of the disaster. Hundreds widening of the gap between the economically powerful and the died and thousands fell ill. Children were born with physical defects. economically less powerful clubs.” Even after researchers had proven that mercury was the cause of the illness, the company continued its dumping for another ten years. It Sports leagues, then, need to address the externality from each stopped only when the production method it was using was team’s personnel decisions. But the market designers are the owners, superseded by a cheaper one. Some of the side effects of market who are not neutral. A possible solution might be to bring the activity cannot be left to the market.
  • 13. Reinventing the Bazaar No Man Is An Island Some externalities can be corrected by defining and enforcing property rights. in other cases the harmful activity can be taxed. In extreme cases the only solution is to ban it. In a well-designed market, the rules are set so that transactions bring few uncompensated side effects. As the ocean fisheries and sports leagues illustrate, however, such a design can be hard to set right. We have now addressed all of the basic features of market design. A workable platform for markets has five elements: information flows smoothly; people can be trusted to live up to their promises; competition is fostered; property rights are protected but not overprotected; and side effects on third parties are curtailed. For the remainder of the book I will look at how these five elements of market design get to be implemented—or fail to be.